Valuing seed and early stage companies

I watched the interview below from the On Demand Conference yesterday. It’s between Semil Shah, founder of the Haystack Fund, and Shervin Pishevar of Sherpa Ventures.

In addition to being an investor in Munchery which I wrote about earlier, Shervin is also an investor in on-demand companies like Uber and Taskrabbit. I found the whole interview very valuable to see how one of the world’s best investors in on-demand startups thinks about his investments in the space.

However, the most interesting part of the talk for me was when Shervin shared how he led Uber’s Series B in 2011 while at Menlo Ventures. At the time, Uber had annual net revenue of $1.8M (a 20% commission on $9M of ride value) and Shervin valued the company at $290M. Shervin doesn’t state whether this was a pre-money or post-money valuation but it doesn’t really matter. Given the $37M round size, this implies a 140X to 160X revenue multiple.

Looking at the valuation from the perspective of a revenue multiple, it’s very difficult to justify. As Shervin shares, the reason he was willing to pay that much for the company was because he had a vision for how big it could get. This is a great reminder that, let alone a discounted cash flow analysis, even a multiples-based analysis doesn’t work when valuing seed and early stage companies. A much better approach is to think about how big a company can get, assign a probability to it reaching that outcome, and apply your target rate of return on the capital you’re investing.

The key determinant of how much you’re willing to pay is clearly how big you believe the company can get. Seeing this requires tremendous vision.